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"PAPER  READ  BEFORE  "PACIFIC  COAST  GAS  ASSO- 
CIATION. OAKLAND,  CALIF..  SEPT.  19.  20.  2 1 .  f  91 1 


Reprint 

JOURNAL  OF  ELECTRICITY, 
'POWER  AND  CAS 


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RATES  FOR  GAS  SERVICE. 

BY   C.   L.   CORY. 


In  all  probability  more  money  has  been  expended 
in  the  various  States  and  cities  of  the   Pacific  Coast 
during  the  past  decade,   either  directly  or  indirectly, 
^    =^  in  connection  with  litigation  or  other  phases  in  deter- 

mining the  rates  for  gas  service,  than  has  been  the 
cost,  in  the  same  territory,  of  all  experimental  and 
other  related  scientific  and  enQ;ineerin2:  work  of  im- 
proving  the  methods  and  reducing  the  cost  of  the 
manufacture,  distribution  and  sale  of  gas.  Certainly, 
there  is  no  problem  connected  with  the  gas  industries 
more  important  than  that  of  rates.  There  is  a  spend- 
ing and  receiving  side  to  every  organization.  It  is  the 
difiference  between  what  is  spent  to  provide  a  com- 
modity and  the  amount  for  which  the  commodity  in 
the   aggregate   is   sold   which   establishes   the   desira- 


bility of  the  business.  Unlimited  commendation  is  due 
the  gas  engineers  of  the  Pacific  Coast  for  the  work 
they  have  done  in  recent  years  to  improve  the  pro- 
cesses of  gas  manufacture,  including  all  of  the  notable 
advances  in  high  pressure  distribution  and  improve- 
ment of  service,  as  well  as  the  increased  economies 
and  reduced  cost  of  production.  It  is  but  natural, 
therefore,  that  we  should  be  equally  interested  in 
the  consumption  and  use  and  especially  the  proper 
rates  to  be  charged  for  gas,  not  only  from  the  stand- 
point of  the  manufacturing  companies,  but  quite  as 
much  must  the  consumer's  position  in  the  matter 
be  given  due  consideration. 

*The  term  "public  utility"  has  been  defined  as 
meaning  and  embracing  each  corporation,  company, 
firm,  individual  and  association,  such  as  express, 
telephone,  telegraph,  sleeping  car,  freight-line,  equip- 
ment, electric  light,  gas,  natural  gas,  pipe  line,  water- 
works,  messenger,   signal,   union   depot,   water  trans- 

*L,a\vs    of   Ohio,    Langdon    Act.    1910,    Page    429. 

L'28254 


Rates  for  Gas  Service 


portation,  heating  and  cooling  companies ;  street, 
steam,  suburban  and  interurban  railroad  companies ; 
also  any  plant  or  property  owned  or  operated  by 
such  companies,  corporations,  firms,  individuals  or 
associations. 

It  is  such  companies  as  above  indicated  that  pro- 
vide service  to  the  public,  and  the  rates  for  such  serv- 
ice should  be  based  primarily  upon  the  cost  of  pro- 
viding adequate  and  satisfactory  service.  To  deter- 
mine this  cost  is  many  times  a  difficult  task,  and  espe- 
cially So  when  the  devices  and  system  required  to  pro- 
vide the  service  are  not  fully  developed  and  standard- 
ized. As  an  illustration,  the  rates  for  freight  and  pas- 
senger service  between  San  Francisco  and  Los  An- 
geles, whether  by  steamer  or  by  rail,  have  been  estab- 
lished for  such  a  length  of  time  that  it  is  not  a  diffi- 
cult matter  to  decide  upon  the  reasonableness  of  such 
rates,  and,  therefore,  rates  may  be  established  that  are 
more  or  less  permanent  and  not  subject  to  material 
revision  from  year  to  year.  However,  to  determine 
adequate  freight  and  passenger  rates  between  these 
cities  using  the  automobile  or  the  aeroplane  would 
be  exceedingly  difficult,  if  not  impossible.  However, 
it  is  not  to  be  concluded  that  in  future  years,  service, 
both  passenger  and  freight,  with  the  newest  aerial 
devices  for  transportation  may  not  become  so  well 
established,  reliable  and  satisfactory  that  rates  of 
service  might  not  be  readily  determined. 

The  business  of  manufacturing  and  supplying  gas 
hdS  been  very  thoroughly  standardized,  although  pro- 
gress is  constantly  being  made  in  the  methods  of  man- 
ufacture as  well  as  the  increased  economies  in  distri- 
bution. High  pressure  systems  have  been  introduced 
in  recent  years.  The  methods  of  gas  manufacture  from 
California  crude  oil  on  the  Pacific  Coast  have  been  per- 
fected within  a  comparatively  recent  date.  As  com- 
pared with  many  other  public  utility  enterprises,  how- 
ever, the  gas  business  has  been  established  so  long 
that  the  determination  of  the  cost  of  service  is  com- 
paratively easy. 

The  cost  of  delivering  gas  to  the  consumer  neces- 
sarily embraces  the  determination  among  other  things 


Rates  for  Gas  Service 


of  a  fair  valuation  of  the  plant  that  is  devoted  to 
public  use,  the  gross  earnings  under  any  given  set  of 
rates  and  the  reasonable  operating  expenses  when 
depreciation  of  the  physical  property  and  adequate  re- 
turns on  the  investment  are  included. 

The  general  information  necessary  in  order  to 
arrive  at  the  proper  rate  for  gas  service  may,  in  gen- 
eral, be  subdivided  as  follows: 

1st.  The  valuation  or  appraisal  of  the  plant  used 
for  the  manufacture  and  distribution  of  gas. 

2d.  The  annual  cost  of  operation,  including  a 
complete  segregation  of  all  accounts  set  forth  in  such 
a  manner  as  to  indicate  the  different  operating  costs 
per  1000  cubic  feet  of  gas  manufactured  and  sold. 

3d.  A  statement  of  the  quantity  of  gas  made  and 
sold  for  a  number  of  years,  preferably  not  less  than 
five,  and  the  total  revenues  received  each  year  from 
the  sale  of  gas. 

Valuation. 

There  are  a  number  of  fundamental  principles  in- 
volved in  obtaining  the  valuation  of  a  gas  plant  and 
system  to  be  used  in  determining  a  proper  rate  for 
gas  service.  It  is  quite  as  important  that  corporations 
themselves  should  determine  for  each  year  the  valua- 
tion of  the  system  upon  which  a  return  on  the  invest- 
ment is  to  be  earned  as  it  is  for  this  valuation  to  be 
determined  by  any  public  body,  whether  only  inci- 
dentally or  directly  concerned,  with  the  fixing  of  rates. 

The  original  cost  of  construction,  the  cost  of  re- 
construction or  reproduction  new,  the  cost  of  repro- 
duction new  less  depreciation,  the  present  value,  the 
assets  and  liabilities  taken  as  a  whole,  the  capitaliza- 
tion, the  bonds  and  stock  outstanding,  and  the  gross 
earnings  and  operating  expenses  are  all  elements  that 
should  be  considered  in  determining  the  valuation  of 
a  public  utility  for  rate  fixing  or  other  purposes.  Each 
of  these  elements  constitutes  evidence  of  wdiat  is  a 
fair  value.  The  original  cost,  the  cost  of  reproduc- 
tion new  and  the  present  value  bear  a  very  close  re- 
lation to  the  physical  property  of  the  plant  and  are, 
therefore,  most  usually  considered  of  the  greatest  im- 


Rates  for  Gas  Service 


portance  in  determining  the  proper  valuation.  Which 
of  these  three  elements  gives  the  best  indication  of 
the  value  will  vary  in  each  individual  case. 

The  original  cost  can,  if  all  records  of  construc- 
tion are  available,  be  usually  determined  by  what 
is  known  as  the  historical  method.  The  conditions 
under  which  the  construction  of  the  system  was  car- 
ried out,  whether  all  done  at  once  or  extended  from 
year  to  year  as  the  growth  of  the  business  required, 
will  be  covered  in  this  method  of  determining  the  or- 
iginal cost.  When  proper  charges  only  are  included 
and  no  mistakes: have  been  made,  for  which  the  build- 
ers may  be  properly  held  responsible,  the  original  cost 
represents  the  investment  that  has  actually  been  made 
in  the  physical  property  of  the  plant. 

The  rapid  growth  of  many  systems,  however,  and 
the  rapidity  with  which  changes  have  been  made, 
coupled  with  inadequate  records,  make  it  many  times 
practically  impossible  to  determine  the  original  cost 
with  any  degree  of  reliability.  Much  depends 
upon  the  manner  in  which  accounts  and  records  have 
been  kept.  In  order  to  be  of  value  they  should  show 
the  actual  cost  of  the  different  parts  of  the  plant, 
segregating  labor  and  material,  the  cost  of  engineer- 
ing superintendence,  management,  and  administration, 
the  amount  that  has  been  allowed  as  interest  on  the 
capital  during  the  construction  period,  the  cost  of 
financing,  which  will  include  the  discount  at  which 
bonds  were  sold,  the  basis  upon  which  stock  has  been 
issued  or  sold,  all  promotion  expenses  and  similar 
items.  It  is  not  difficult  to  imagine  records  which 
would  give  the  above  information,  but  I  venture  to 
say  that  most  rare  is  it  that  the  original  cost  of  a 
gas  plant  operating  at  the  present  time  may  be  ob- 
tained entirely  in  such  a  complete  and  satisfactory 
manner. 

Moreover,  the  original  cost  even  when  determined 
in  full  detail  may  not  be  the  valuation  upon  which  rea- 
sonable returns  should  be  allowed.  It  is  a  question 
of  equity  between  owners  of  the  plant  on  one  hand 
and  the  customers  on  the  other.  The  owners  are  en- 
titled to  a  reasonable  return  upon  what  they  have  in- 


Rates  for  Gas  Service 


vested,  while  the  customers  should  not  pay  rates  for 
service  that  will  yield  more  than  an  adequate  return 
upon  the  investment  necessary  to  supply  such  service. 
If  the  plant  has  been  built  when  prices  were  abnor- 
mally high  and  money  has  been  lost  through  lack  of 
reasonable  skill,  excessive  promotion  fees  and  dis- 
counts, private  understandings  between  the  builders 
of  the  plant  and  the  contractors,  the  original  cost  may 
be  decidedly  greater  than  the  valuation  on  which  the 
investors  should  be  allowed  to  earn. 

Conversely,  it  may  be  that  the  plant  was  con- 
structed when  the  prices  for  labor  and  material  were 
excessively  low,  or  a  great  portion  of  the  plant  may 
have  been  obtained  through  failure  of  previous  owners 
to  successfully  carry  on  the  business,  due  either  to 
temporary  financial  difficulties  or  what  has  been  more 
common,  great  strides  in  the  method  of  manufacture, 
resulting  ultimately  in  foreclosure.  In  such  a  case 
the  original  cost  would  hardly  be  a  fair  figure  upon 
which  to  base  the  valuation  for  rate  fixing  purposes, 
as  the  foresight  and  enterprise  of  the  present  owners 
certainly  justifies  some  regard. 

The  original  cost  is  so  rarely  available  that  the 
cost  of  reproduction  new  of  the  plant  usually  must  be 
determined.  A  great  deal  of  engineering  knowledge 
and  detail  work  is  necessary  to  obtain  this  result.  In- 
variably, a  complete  inventory  of  the  physical  property 
is  the  first  step  required.  The  only  satisfactory  in- 
ventory is  one  obtained  as  a  result  of  actual  inspection 
and  enumeration,  aided,  as  much  as  possible,  by  all 
the  records  available,  and  supplemented  by  such  addi- 
tional information  as  may  be  had  from  the  various 
heads  of  departments  and  other  employees  of  the  com- 
pany. Such  an  inventory  should  include  for  each  dif- 
ferent part  of  the  property  the  amount  of  labor  and 
material  required  to  provide  ready  for  operation  each 
element  of  the  completed  plant.  The  next  step  con- 
sists in  obtaining  from  all  data  obtainable  a  suitable 
price  per  unit,  not  only  of  each  element  of  the  prop- 
erty, but  the  labor  and  material  required  to  install 
the  devices  in  position  ready  for  operation.  It  is  well 
in  determining  such  unit  prices  to  take  a  period  cov- 


10  Rates  for  Gas  Service 


ering  at  least  five  years  and  obtain  the  average  in  this 
manner.  The  total  and  average  cost  of  the  labor  and 
material  that  has  entered  into  the  plant  ready  for  op- 
eration is  thus  obtained. 

Inventories. 

Inventories  of  the  actual  physical  property  which 
taken  together  go  to  make  up  a  modern  gas  plant 
and  system  should  include  the  following: 

Real  estate.  Furniture    and    fixtures. 

Buildings.  Automobiles,    motorcycles,    etc. 

Gas    works,    including   holders.  Stable    equipment. 

Street  mains.  Tools. 

Services.  Supplies. 

Meters,    regulators   and    lamps.  Working    capital. 

Real  Estate. 

A  complete  list  of  all  real  estate  used  wholly 
or  in  part  for  the  purpose  of  the  manufacture  and 
the  supplying  of  gas  should  be  included  in  the  inven- 
tory. The  values  placed  upon  this  real  estate  should 
be  determined  in  so  far  as  possible  by  actual  sales 
of  property  in  the  vicinity  of  the  real  estate  in  ques- 
tion when  used  for  a  similar  purpose.  The  purpose 
for  which  the  property  is  used  must  always  be  taken 
into  consideration.  Disinterested  real  estate  men  are 
usually  able  to  give  information  leading  to  a  rational 
decision  in  such  matters.  Unfortunately,  assessments 
for  taxation  purposes  are  not  of  material  assistance 
in  appraising  such  real  estate.  On  the  other  hand 
the  actual  figures  at  which  adjacent  property  is  sold 
are  rarely  available. 

When  a  gas  company  has  real  estate  not  actually 
in  use  but  is  holding  it  for  future  occupancy  the  ques- 
tion naturally  arises  should  such  real  estate  be  in- 
cluded in  arriving  at  the  valuation  of  the  plant  for 
the  purpose  of  determining  the  proper  rate  for  the  sale 
of  gas  at  any  given  time. 

In  arriving  at  a  conclusion  in  this  matter,  it  is 
best  to  proceed  upon  the  principle  that  it  is  proper 
to  include  all  property  actually  required  and  used  in 
the  carrying  on  of  the  business  at  the  time  in  question 
and  not  to  include  such  real  estLte  not  required  or 
used  on  the  date  the  valuation  is  made.  However,  at 
some  later  period  when  the  real  estate  is  actually  put 


Rates  for  Gas  Service  il 

to  use  and  occupied  by  buildings  and  equipment,  that 
are  a  part  of  the  operating  system,  in  arriving  at  the 
valuation,  there  should  be  added  interest  and  taxes 
during  such  time  as  the  investment  in  such  lands  has 
been  tied  up  but  not  productive.  On  any  other  prin- 
ciple, customers  of  today  would  pay  a  rate  for  serv- 
ice in  excess  of  what  they  should  and  customers  of 
the  future  may  pay  relatively  less  and  thereby  benefit 
unduly. 

Buildings. 

All  of  the  buildings  owned  by  the  compan}'^  as  a 
part  of  its  operating  system  should  be  included  in  the 
inventory  and  so  segregated  that  it  will  be  possible 
to  separate  the  structures  such  as  office  buildings,  etc., 
from  the  structures  required  as  a  part  of  the  manu- 
facturing plant.  This  should  be  done  in  order  to 
obtain  the  cost  of  the  manufacture  of  gas  as  delivered 
to  the  holders  separate  from  the  general  expenses  con- 
nected with  the  operating  of  the  property  usually  con- 
nected with  the  expense  of  the  general  offices  of  the 
company.  The  inventory  costs  of  all  buildings  are 
usually  best  obtained  from  the  plans,  specifications  and 
contracts  or  other  records  of  the  company.  The  con- 
dition of  the  buildings  in  general  usefulness  and  prob- 
able future  life  should  be  taken  into  consideration  in 
determining  the  probable  value  based  upon  original 
cost,  cost  of  reproduction  new  and  present  value. 

Gas  Works. 

The  gas  works  inventory  must  include  besides 
buildings  all  of  the  equipment  necessary  in  the  manu- 
facture, metering  and  storing  of  gas,  such  as  boilers, 
blowers,  compressors,  generators,  exhausters,  holders, 
heaters,  pumps,  piping,  purifiers,  scrubbers,  and  mis- 
cellaneous equipment.  The  date  of  purchase  or  con- 
tract and  the  date  when  installation  was  commenced 
and  completed  as  well  as  the  type  of  apparatus  and 
by  whom  manufactured,  should  be  included  as  a  part 
of  the  inventory.  When  possible,  the  cost  of  each  ele- 
ment of  the  entire  manufacturing  plant  ready  for  oper- 
ation segregating  labor  and  material  is  desirable. 


12  Rates  for  Gas  Service 

Street  Mains. 

An  inventory  of  street  mains  is  best  obtained  by 
tabulating  and  mapping  from  work  reports  all  installa- 
tions and  removals  for  as  long  a  period  as  records  are 
available.  Scaling  street  mams  from  maps  in  order 
to  obtain  the  aggregate  length  of  the  various  sizes 
should  only  be  resorted  to  when  the  actual  records 
of  installation  are  not  available.  The  size  of  all  street 
mains  including  fittings  and  accessories  of  every  char- 
acter and  classified  as  to  the  material  used,  such  as 
wrought  iron,  cast  iron  or  casing,  should  be  included 
in  the  inventory.  In  a  similar  manner  the  cost  of  re- 
placing the  street  surface  in  the  various  kinds  of  pav- 
ing should  be  determined  from  the  most  recent  records 
available  for  such  work. 

The  item  of  paving  in  determining  the  value  of 
underground  street  mains  and  services  has  been  vari- 
ously considered.  Every  legitimate  expenditure  in 
adapting  the  utility  to  the  progress  and  coiiimunity 
growth,  even  if  this  involves  the  removal  of  the  plant 
from  one  locality  of  the  city  to  a  distant  and  more 
remote  location,  is  a  proper  charge  to  construction. 
All  expenditures  for  putting  down  pavement  by  the 
company  as  required  by  the  city  or  the  cost  of  cutting 
through  such  pavement  for  extensions  and  construc- 
tion purposes,  and  its  replacement,  are  unquestionably 
proper  capital  charges.  However,  it  is  a  question 
whether  a  gas  company  may  properly  capitalize  the 
expense  of  municipal  betterment  which  it  has  not  borne 
and  when  such  benefits  to  the  gas  company  are  only 
incidental  and  can  only  exist  from  the  standpoint  of 
the  cost  of  actually  reproducing  their  underground 
system,  after  the  street  has  been  paved,  when  as  a 
matter  of  fact  the  existing  underground  mains  and 
services  were  laid  before  the  paving  was  actually  put 
down.  The  cost  of  such  paving  is  not  a  proper  ele- 
ment of  value  when  the  cost  of  laying  such  pavement 
has  not  been  paid  for  by  the  gas  company  nor  any 
expense  incurred  therewith,  providing  of  course  that 
all  costs  borne  by  the  company  of  changmg  the  grade 
or  depth  of  underground  mains  and  services,  in  order 


Rates  for  Gas  Service  13 

to  adapt   them   to  conditions  required  for  paving  by 
the  city,  are  included  in  the  capital  account. 

Services. 

In  obtaining  the  inventory  of  services,  it  is  most 
satisfactory  to  list  all  services,  obtaining  thereby  the 
size,  length,  and  character  of  each  service  as  shown 
by  the  records  of  this  department.  Only  that  portion 
of  the  service  belonging  to  the  company  should  be 
included  and  if  consumers  have  paid  for  any  portion 
of  the  service  that  portion  should  be  considered  as  be- 
longing to  the  company.  The  total  value  of  the  ser- 
vices should  represent  only  those  actually  owned  by 
the  company  and  in  general  should  not  include  any 
services  or  reproduction  of  any  services  within  cus- 
tomers' premises  unless  the  cost  of  the  same  has  ac- 
tually been  met  by  the  company. 

In  order  to  arrive  at  a  unit  cost  of  services,  it 
is  best  to  obtain  the  actual  labor  and  material  charge 
for  a  number  of  services  installed  in  various  parts  of 
the  district  served  and  at  different  seasons  of  the  year, 
to  get  a  reliable  average  cost  per  unit  length  of  service. 

Meters,  Regulators,  Etc. 

The  inventory  of  meters  in  service  is  usually 
readily  obtained  from  the  company's  records.  The 
inventory  cost  of  the  meters  should  include  the  nec- 
essary testing,  painting  and  all  storeroom  expense. 
The  cost  of  installing  the  meters  should  include  all 
costs  from  the  time  the  order  leaves  the  general 
office  until  the  order  and  record  of  installation  are 
returned  to  the  general  office.  The  time  cards  of 
meter  installers  covering  a  considerable  period  can 
with  great  advantage  be  used  to  determine  the  cost 
of  installing  meters  of  different  sizes. 

Furniture  and  Fixtures,  Automobiles  and  Motorcycles, 
Stable  Equipment,  Tools  and   Supplies. 

Complete  inventories  should  be  made  of  the 
property  owned  and  in  actual  use  by  the  company  for 
the  carrying  on  of  the  business  covering  all  subsidiary 
items  such  as  furniture  and  fixtures,  automobiles  and 
motorcycles,    stable    equipment,     tools    and     supplies. 


14  Rates  for  Gas  Service 


Only  those  supplies  should  be  included  which  are 
active  and  of  the  normal  quantity  carried  in  stock  and 
necessary  for  the  operation  of  the  company's  business. 

Working  Capital. 

A  gas  plant  and  system  in  operation  must  have 
working  capital  as  well  as  fixed  capital.  Stores  and 
supplies  which  are  included  in  the  fixed  capital  do 
not  represent  all  of  the  working  capital  such  plants 
require.  There  must  be  available  a  reasonable  cash 
balance  and  other  current  allowances  in  order  to  oper- 
ate economically  and  efifectively.  Just  what  sum  rep- 
resents a  fair  amount  for  working  capital  is  nearly 
always  a  matter  of  judgment.  From  the  amount  of 
working  capital  usually  carried  by  such  companies 
and  from  the  amount  that  is  required  by  other  similar 
public  utility  corporations,  it  appears  that  as  an  av- 
erage for  the  year  a  sum  equalling  the  accounts  re- 
ceivable and  cash  on  hand  less  the  accounts  payable 
and  consumers  advance  payments  is  a  reasonable 
allowance.  The  cash  on  hand,  however,  shoul'd  be  con- 
sidered as  that  which  is  ordinarily  required  for  the 
operation  of  the  plant  and  the  conduct  of  the  business, 
including  contingencies  and  emergencies,  and  should 
not  include  the  capital  or  ready  cash  necessary  for  the 
construction  of  extensions  or  enlargement  of  the  plant, 
or  balances  resulting  from  the  sale  of  bonds  or  stock 
or  in  any  case  exceed  the  amount  normally  needed 
and  used  by  the  company  as  an  operating  property. 

Such  an  inventory  coupled  with  what  might  be 
called  the  inventory  costs  serves  to  obtain  the  de- 
tailed and  segregated  costs  of  the  various  elements 
going  to  make  up  the  physical  property  of  the  plant. 
In  addition  in  order  to  estimate  the  total  valuation  it 
is  necessary  to  ascertain  as  nearly  as  may  be  the  time 
required  for  construction  in  order  that  interest  upon 
the  investment  during  the  construction  period  may  be 
estimated.  The  cost  of  engineering,  supervision,  fire 
and  casualty  insurance,  administration,  legal  expenses 
and  other  factors  must  also  be  obtained,  preferably 
irom  the  actual  working  conditions  during  which  re- 
cent construction  work  was  carried  out. 


Rates  for  Gas  Service  15 


Taken  together  the  cost  of  reproduction  new  of 
the  physical  plant  is  usually  considered  to  be  the  sum 
of  the  elements  above  enumert^ted.  The  cost  of  repro- 
duction new  has  been  variously  interpreted,  sometimes 
erroneously,  especially  when  it  has  been  held  to  mean 
a  '  ystem  identical  with  the  one  the  valuation  of  which 
is  under  consideration.  Properly,  it  should  be  under- 
stood as  a  plant  of  similar  character  and  equal  effi- 
ciency. The  age  of  the  system  will  have  much  to  do 
in  indicating  the  fairness  with  which  the  cost  of  re- 
production new  is  considered. 

It  will  depend  upon  conditions  as  to  whether  the 
cost  of  production  new  and  the  original  cost  very 
materially.  One  of  the  principal  dififerences  which 
will  be  found  will  be  in  the  size  and  capacity  and  num- 
ber of  units  in  the  two  cases.  Gas  plants  are  probably 
never  built  in  a  single  year,  nor  used  exactly  as  they 
were  originally  constructed  for  a  number  of  years. 
The  original  cost  will  probably  properly  rover  the 
plants  as  installed  with  small  units,  while  the  cost 
of  reproduction  new  may  be  considered  to  cover  only 
the  cost  of  a  smaller  number  of  much  larger  units 
having  the  same  aggregate  capacity.  Especially  would 
this  difference  arise  in  connection  with  the  distribution 
system,  both  mains  and  services.  Originally  one  sin- 
gle main  on  one  side  of  the  street  of  comparatively 
small  size  may  have  been  adequate  to  provide  gas  serv- 
ice in  that  particular  vicinity.  Later  on  it  became 
necessary  to  lay  an  additional  gas  main  many  times 
larger  than  the  original  and  as  is  often  the  case  this 
later  main  is  laid  upon  the  opposite  side  of  the  street, 
resulting  in  the  cutting  of  all  services  leading  to  prop- 
erty on  the  side  of  the  street  where  the  new  main  is 
laid  and  the  connection  of  those  services  into  the  new 
main,  instead  of  the  old.  As  viewed  from  present  re- 
quirements, one  gas  main  alone  might  be  considered 
in  obtaining  the  cost  of  reproduction  new,  while  the 
actual  cost  would  necessarily  be  greater. 

Depreciation  in  Its  Relation  to  Valuation. 

While  the  original  cost  as  well  as  the  cost  of  re- 
production new  are  ordinarily  of  the  greatest  import- 


16  Rates  for  Gas  Service 

ance  in  determining  the  proper  valuation  upon  which 
earnings  should  be  based,  there  is  what  is  often  called 
the  present  or  existing  value,  or  cost  of  reproduction- 
new  less  depreciation,  which  must  be  given  consid- 
eration in  determining  the  valuation  in  question. 
Especially  is  this  the  case  in  plants  the  rates  for  gas 
service  from  which  have  been  ample  to  cover  operating 
expenses,  including  depreciation,  and  a  fair  amount 
for  interest  and  profits,  but  the  amount  collected  for 
depreciation  has  not  been  used  as  it  should  be  and 
set  aside  for  replacing  portions  of  the  plant  discarded 
because  of  their  becoming  obsolete,  inadequate  or 
worn  out,  but  on  the  contrary  has  been  distributed  to 
the  stockholders  in  the  shape  of  dividends. 

Depreciation  should  be  considered  as  the  amount 
that  must  be  regularly  set  aside  to  cover  all  portions 
of  the  plant  that  are  discarded  because  of  wear  and 
tear,  inadequacy,  obsolescence  and  general  unavoid- 
able decay.  It  is  an  operating  expense  and  should  be 
borne  by  the  customers  through  the  rate  paid  by  them 
for  the  service  rendered  by  the  utility.  But  as  it  is 
paid  by  the  customers  it  must  be  set  aside  by  the 
company  and  used  when  needed  for  the  renewal  of 
worn  out  and  useless  portions  of  the  entire  system,  and 
under  no  circumstances  should  the  cost  of  such  re- 
newals be  made  an  additional  charge  to  the  capital 
or  construction  account  except  when  the  replac<fd 
equipment  is  of  greater  capacity  than  that  which  is 
taken  out.  Care  must  also  be  taken  that  the  O'pfT- 
ating  charge  properly  known  as  depreciation  shall  not 
be  used  for  ordinary  maintenance  and  repair.  Actual 
additions  and  extensions  to  plant  which  should  be 
•charged  to  the  construction  or  capital  account,  replace- 
ment of  equipment  set  aside  as  a  result  of  deprecia- 
tion, and  ordinary  repair  and  maintenance  costs,  must 
all  three  be  most  carefully  separated  and  completely 
segregated  in  the  engineering  records  as  well  as  the 
financial  accounts. 

If    construction,    depreciation,    repair    and    main- 
tenance accounts  are  not  so  considered  and  deprecia- 
tion is  borne  by  the  customers  as  a  result  of  being 
'included  in  the  operating  expense,  and  such  deprecia- 


Rates  for  Gas  Service  17 

tion  fund  is  not  used  to  keep  the  plant  in  its  proper 
condition,  but  is  paid  in  dividends  to  the  stockholders, 
it  is  practically  equivalent  to  the  payment  of  divi- 
dends out  of  capital.  Rates  of  service  should  be  such 
as  to  include  a  reasonable  charge  for  depreciation,  and 
if  the  rates  are  such  as  to  do  this  and  the  amount 
necessary  to  cover  depreciation  is  not  used  as  it  should 
be,  it  cannot  mean  anything  but  that  the  money,  either 
in  surplus  or  dividends  is  going  to  the  stockholders 
instead  of  being  used  for  the  purpose  intended. 

An  allowance  for  depreciation  obligates  the  com- 
pany to  use  of  this  money  in  keeping  the  plant  in 
thorough  operating  condition,  and  if  it  is  not  so  used 
but  is  turned  over  to  the  stockholders,  it  simply  means 
that  a  part  of  their  capital  is  being  returned  to  them, 
thereby  reducing  the  investment  in  the  plant.  If  this 
is  .the  case,  as  a  matter  of  fact  the  investment  is  so 
reduced  and  there  should  be  corresponding  reduction 
made  in  the  actual  investment  presumably  represented 
by  the  original  or  cost  of  reproduction  new.  In  such 
instances,  if  the  owners  of  the  property,  instead  of 
keeping  up  the  plant  as  they  should  by  the  proper 
use  of  the  annual  depreciation  charge,  have  appropri- 
ated for  their  own  use  the  money  contributed  by  their 
customers,  the  annual  depreciation  should  each  year 
be  deducted  from  the  valuation  of  the  plant  which 
might  otherwise  be  obtained. 

Depreciation,  like  interest,  continues  constantly 
and  is  always  present.  Every  part  of  the  physical 
property  of  any  system  exclusive  of  the  land  begins 
to  depreciate  when  the  plant  is  completed  and  ready 
for  operation  ;  therefore,  the  depreciation  charge  should 
be  constant.  It  of  course  may  be  that  such  deprecia- 
tion covering  a  number  of  years  may  be  arrived  at  as 
an  average  for  a  long  period,  and  it  will  not  be  neces- 
sary to  expend  the  average  each  j^ear.  This  is  of  minor 
importance,  however,  providing  the  methods  by  which 
the  depreciation  charges  are  obtained  are  sound  and 
reasonable. 

Two  methods  are  in  common  use  for  determining 
depreciation.  The  first  is  known  as  the  straight  line 
method,    which     involves    determining    the    probable 


18  Rates  for  Gas  Service 

ultimate  life  of  each  element  of  the  system, 
consideration  also  being  given  to  the  value  of  the 
discarded  element  as  junk  at  the  end  of  the  period. 
In  the  straight  line  method  it  is  assumed  that  during 
the  entire  life  of  each  element  of  the  plant  the  de- 
preciation is  uniform,  which  of  course  is  not  ordi- 
narily the  case  as  the  rate  of  depreciation  of  a  plant 
as  a  whole  is  much  more  rapid  during  the  latter  part 
of  its  life  than  during  the  first  years  of  its  use.  Fair- 
ness to  customers,  however,  in  the  different  years,  as 
well  as  safety  to  investors,  indicates  clearl}'  the  wis- 
dom and  correctness  in  considering  the  depreciation 
uniform  throughout  the  entire  life  of  each  portion  of 
the  plant. 

The  second  method  of  determining  depreciation 
is  upon  the  assumption  that  each  year  an  amount  is 
to  be  set  aside  and  invested  at  compound  interest  60 
that  this  amount  plus  interest  will  be  available  to 
cover  the  cost  of  the  replacement  needed  at  the  end 
of  the  period  when  the  device  or  element  is  discarded, 
and  replacement  necessary.  The  so-called  rates  of  de- 
preciation will  naturally  be  less  in  the  latter  method 
than  in  the  former,  since  it  is  assumed  that  the  de- 
preciation fund  will  earn  interest  from  the  end  of 
the  first  year  or  even  shorter  period.  If  we  consider 
the  life  of  some  portions  of  a  plant  to  be  between 
twenty  and  thirty  years,  with  the  latter  method  it  is 
necessary  for  us  to  in  advance  assume  an  interest  rate 
which  will  continue  during  this  entire  period  and  thi§ 
is  an  assumption  which,  judged  by  the  last  twenty- 
five  year  period,  is  hardly  justifiable. 

It  may  very  properly  be  said  that  neither  method 
exactly  corresponds  to  actual  experience.  At  the 
same  time  the  rate  of  depreciation  is  something  that 
must  be  carefully  estimated  for  each  individual  plant 
and  the  data  required  compiled  from  the  best  informa- 
tion obtainable  from  those  who  have  been  in  charge 
of  construction  and  operation  preferably  for  a  number 
of  years.  If  new  devices  are  constantly  being  per- 
fected and  introduced  rates  of  depreciation  will  be 
high  due  to  the  fact  that  older  apparatus  will  become 
obsolete   and   inadequate    at   an    early   date.      On    the 


Rates  for  Gas  Service  19 

other  hand,  if  the  different  portions  of  the  plant  are 
not  subject  to  change  as  a  result  of  improved  or  modi- 
fied methods  or  distribution,  rates  of  depreciation  will 
be  low,  providing,  of  course,  that  wear  and  tear  and 
ordinar}-  deterioration  are  not  severe  with  a  reason- 
able expenditure  for  ordinary  replacement  and  main- 
tenance. 

Intangible  Elements  of  Value. 

In  determining  the  proper  valuation,  therefore, 
the  original  cost,  cost  of  reproduction  new,  present 
value  as  affected  by  depreciation  should  all  be  taken 
into  consideration.  They  are  not  the  only  elements, 
however,  although  they  are  usually  the  most  readily 
determined;  One  element  of  value  often  suggested  is 
that  of  "good  will."  The  good  will  of  a  business  is  an 
asset  that  cannot  be  ignored  in  determining  the  valua- 
ation  of  a  property,  provided  the  element  of  good  will 
is  inherent  in  the  business  of  a  public  service  corpora- 
tion which  may  have  a  practical  monopoly.  One  of 
the  most  comprehensive  and  generally  accepted  defini- 
tions of  good  will  is  by  Judge  Story : 

"Good  will  may  properly  enough  be  described  to  be  the  ad- 
vantage or  benefit  which  is  acquired  by  an  establishment,  be- 
yond the  mere  value  of  the  capital  stock,  funds,  or  property 
employed  therein  in  consequence  of  the  general  public  patron- 
age and  encouragement  which  it  receives  from  constant  or 
habitual  customers  on  account  of  its  local  position  or  common 
celebrity  or  reputation  for  skill,  affluence,  punctuality,  or  from 
other  accidental  circumstances  or  necessities,  or  even  from 
ancient   partialities    or   prejudices." 

Judge  Hough  must  have  had  this  definition  of 
good  will  in  mind  in  the  case  of  Consolidated  Gas 
Company  vs.  The  City  of  New  York,  in  which  he  says  : 

"There  is  nothing  in  the  nature  of  the  business  enabling 
it  to  acquire  good  will  in  the  property  sense  or  indeed  in  any 
other.  It  is  required  by  law  to  furnish  gas  to  all  demanding 
it  within  a  certain  distance  of  the  mains:  and  it  owns  the 
mains,  service  pipes  and  meters.  V^''hat  induces  a  customer 
to  remain  with  this  company,  its  successor  or  vendee?  Nothing 
that  I  can  imagine,  except  a  desire  to  avoid  the  nuisance  of 
street  digging  in  front  of  his  house;  a  digging,  however,  en- 
tailing no  expense  upon  him.  Yet  even  this  nuisance  is  in 
all  human  probability  impossible  of  occurrence  because  of  the 
beneflciallv  monopolistic  character  of  defendant's  present  occu- 
pancv  of  the  streets  of  this  city  *  *  *.  Finally,  this  claim 
of  good  will  seems  to  forget  that  for  many  years  the  price 
of  distribution  of  complainant's  gas  has  been  regulated  by 
law.  A  citizen  is  entitled  to  have  a  clean  street  before  his 
house  because  he  pays  taxes,  inter  alls,  for  that  purpose.  He 
is  much  more  entitled  to  have  complainant's  gas  in  his  house 
because  the  company  must  give  jt  to  him  if  he  pays  for  it.  I 
think  it  apparent  that  the  conceivable  good  will  of  a  gas  com- 
pany in  this  city  is  about  equal  to  that  of  the  street  cleaning 
department    of    the    municipal    government." 


20  Rates  for  Gas  Service 


The  public  service  corporation  operating  where 
competition  exists  may  have  an  element  of  good  will 
in  its  valuation,  but  it  is  certainly  of  little,  if  any, 
consequence  where  the  public  under  any  circumstance^^ 
must  obtain  its  service,  if  at  all,  from  a  single  corpor- 
ation. 

In  a  somewhat  similar  manner  may  the  assumed 
value  of  franchises  be  considered  in  determining  the 
valuation  of  the  property  of  a  public  service  corpora- 
tion. Based  upon  court  decisions,  the  principal  ele- 
ment in  the  value  of  a  franchise  "is  the  earning  capacity 
of  the  property  of  the  corporation  in  connection  with 
which  a  franchise  is  necessary.  Viewed  from  this 
standpoint,  since  the  earnings  must  be  directly  depend- 
ent upon  the  rates  charged  for  service,  it  is  evident 
that  to  include  the  value  of  a  franchise  as  an  element 
in  determining  rates  developes  an  almost  impossible 
situation.  A  franchise  which  is  not  exclusive  can 
have  no  real  value  from  any  standpoint  and  is  in  reality 
little  more  than  a  permit  to  carry  on  the  business  and 
to  do  necessary  work  upon  public  property.  As  an  ele- 
ment of  value,  even  in  the  sale  or  transfer  of  the  prop- 
erty, it  is  questionable  whether  such  a  franchise  would 
be  given  serious  consideration.  If,  however,  a  fran- 
chise is  exclusive  and  is  owned  by  a  company,  it  may 
be  considered  of  value  and  would  be  rightfully  con- 
sidered a  part  of  the  entire  system  if  the  business 
were  sold.  On  this  assumption  it  is  proper  to  con- 
sider a  franchise  as  a  part  of  the  taxable  property 
of  the  company.  On  the  other  hand,  while  there  may 
be  some  cases  where  the  valuation  of  a  property  may 
rightfully  include  a  certain  sum  as  the  value  of  the 
franchise,  yet  when  this  value  must  depend  upon  the 
rates  for  which  service  is  rendered,  it  is  difficult  to  see 
how  it  should  be  considered  as  a  part  of  such  valua- 
tion. 

There  is  an  element  of  value  that  must  be  taken 
into  consideration  in  determining  the  valuation  of 
a  property  and  which  is  sometimes  referred  to  as 
"Goins:  Value."  This  is  sometimes  covered  bv  an 
allowance   usually   in  percentage   to   cover  the   differ- 


Rates  for  Gas  Service  21 


ence  between  the  cost  of  the  physical  property  and  the 
value  of  the  completed  system  in  operation  providing 
service  to  its  customers  and  possessing  numerous  val- 
uable contracts  for  giving  service  in  the  future.  Going 
value  is  of  an  intangible  character  and  may  be  esti- 
mated in  some  instances  by  estimating  the  cost  of 
developing  the  business  which  the  company  enjoys 
at  any  particular  time.  The  data  naturally  is  rarely 
obtainable  to  indicate  the  money  actually  spent  by 
the  company  to  obtain  its  business,  since  in  recent 
years  the  period  of  time  during  which  public  service 
corporations  have  been  ready  for  operation  and  yet 
not  actually  engaged  in  providing  service,  approxi- 
mately at  least  up  to  their  normal  capacity,  has  usually 
not  exceeded  one  or  two  years.  When  the  earnings 
of  a  public  service  corporation  have  not  been  sufficient 
to  meet  reasonable  expenditures  for  the  development  of 
its  business  and  to  cover  operating  expenses,  depre- 
ciation and  a  reasonable  return  on  the  investment,  the 
losses  incurred  in  building  up  the  business  must  be 
considered  as  one  of  the  elements  to  be  included  in 
appraising  a  plant  for  the  purpose  of  determining  the 
proper  rates  for  service. 

Probably  the  most  concise  statement  in  this  con- 
nection is  from  the  decision  of  Justice  Brewer  in  a 
most  noteworthy  decision  in  the  case  of  the  National 
Water  Works  Company  vs.  Kansas  City  in  connec- 
tion with  the  valuation  of  a  waterworks  which  had 
been  taken  by  the  municipality  : 

"The  original  cost  of  the  construction  cannot  control,  for 
'original  cost'  and  'present  value'  are  not  equivalent  terms. 
Nor  ■would  the  mere  cost  of  reproducing  the  waterworks  plant 
be  a  fair  cost,  because  that  does  not  take  into  account  the 
value  which  flows  from  the  established  connections  between 
the  pipes  and  the  buildings  of  the  city.  It  is  obvious  that 
the  mere  cost  of  purchasing  the  land,  constructing  the  build- 
ings, putting  in  the  machinery,  and  laying  tiie  pipes  in  the 
streets — in  other  words,  the  cost  of  reproduction — does  not 
give  the  value  of  the  property  as  it  is  to-day.  A  completed 
system  of  waterworks,  such  as  the  company  has,  without  a 
single  connection  between  the  pipes  in  the  streets  and  the 
buildings  of  the  city,  would  be  a  property  of  much  less  value 
than  that  system  connected,  as  it  is,  with  so  many  build- 
ings, and  earning,  in  consequence  thereof,  the  money  which 
it  does  earn.  The  fact  that  it  is  a  system  in  operation,  not 
only  with  a  capacity  to  supply  the  city,  but  actually  supplying 
many  buildings  in  tlie  city — not  only  with  a  capacity  to  earn, 
but  actually  earning — makes  it  true  that  "the  fair  and  equitable 
value'   is  something  in   excess  of  the  cost  of  reproduction." 

In  general  it  may  be  said  that  the  courts  have 
with  few  exceptions  held  that  going  value  is  an  im- 


22  Rates  for  Gas  Service 

portant  and  A^aluable  consideration  in  determining  a 
fair  valuation  for  the  property  of  a  public  service  cor- 
poration devoted  to  public  service.  The  difficulty, 
however  is  in  obtaining  a  fair  and  proper  figure  in  any 
given  case.  Competition  may  at  any  time  seriously 
affect  any  estimate  which  may  be  made  of  the  prob- 
able value  of  a  going  concern  as  contrasted  with  the 
physical  plant  without  customers  or  contracts.  It 
is  probably  most  satisfactory  to  treat  this  matter  pri- 
marily from  the  standpoint  of  the  excess  value  of  the 
completed  system  in  operation  over  and  above  the 
original  cost,  cost  of  reproduction  new,  or  cost  of 
reproduction  less  depreciation,  of  the  physical  plant. 

If  this  is  done,  however,  such  excess  value  of  the 
completed  operating  system  must  be  considered  en- 
tirely separate  from  a  percentage  which  may  properly 
be  considered  as  approximately  the  contractor's  profit 
who  undertakes  to  design,  build  and  supervise  the 
complete  construction  of  an  entire  system,  turning  it 
over  ready  for  operation  to  its  owners. 

The  true  value  of  a  thing  has  been  defined  as  the 
price  upon  which  a  purchaser  and  a  seller  mutually 
agree  and  at  which  figure  an  actual  transaction  takes 
place.  If  an  existing  plant  and  system  were  to  be 
purchased  and  the  owners  were  willing  to  sell  at  all, 
they  would  surely  take  into  consideration  what  it 
would  cost  the  purchaser  to  duplicate,  not  only  the 
physical  plant,  but  obtain  all  of  the  business  enjoyed 
by  them,  and  the  prospective  purchasers  would  surely 
consider  what  it  would  cost  them  independently  to 
install  a  plant  of  equal  general  efficiency  and  use- 
fulness, including  the  business  developed  and  under 
control  of  the  prospective  sellers.  In  the  long  run, 
the  true  value  must  be  the  capitalization  of  an  assured 
income.  A  certain  portion  of  this  value  is  represented 
by  tangible  property  and  the  remainder,  if  there  be 
any,  must  be  regarded  as  primarily  traceable  to  the 
earning  power  of  the  business. 

Gross  Revenue,  Cost  of  Operation  and  Quantity  of  Gas 
Manufactured  and  Sold. 
Gas  being  a  commodity,  it  is  manufactured,  dis- 
tributed and  sold  to  those  who  use  it.     As  manufac- 


Rates  for  Gas  Service  23 

tured  and  sold  it  is  divided  into  units  which  are  usually 
1000  cubic  feet.  The  operating  expenses  may  be 
properly  divided  into  manufacturing,  including  fuel, 
distribution,  general  expenses,  taxes  and  licenses  and 
depreciation.  For  any  period  the  unit  cost  may  in 
a  general  way  be  obtained  by  dividing  the  total  ex- 
pense by  the  total  quantity  sold  and  the  average  cost 
per  1000  cubic  feet  is  thereby  obtained.  Similarly, 
the  unit  cost  for  fuel  and  other  station  costs,  for  dis- 
tribution, taxes  and  licenses,  depreciation  and  general 
expenses,  may  also  be  determined.  It  is  of  importance 
also  to  know  the  relation  between  the  total  gas  made 
and  delivered  to  the  holders  and  the  quantity  actually 
sold  as  per  customers'  meters.  In  this  manner  definite 
data  is  obtained  for  the  leakage  and  the  reduction  in 
volume  of  the  gas  as  measured  by  the  station  meters 
and  by  customers'  meters. 

The  operating  expenses  can  be  definitely  divided 
under  two  heads,  fixed  and  variable.  The  fixed  costs 
should  include  all  expenses  that  are  independent  of 
the  quantity  of  gas  made  but  which  remain  practically 
constant  whether  the  plant  is  operated  at  or  near  its 
full  output,  or  at  a  fraction  of  this.  Variable  expenses 
include  those  costs  that  vary  with  the  output  and 
may  be  considered  as  of  little  consequence  if  gas  is  not 
made.  Naturally,  these  two  classes  of  costs  are  de- 
pendent and  may  vary  widely. 

It  is  not  always  possible  to  make  a  definite  segre- 
gation of  these  fixed  and  variable  expenses,  but  when 
necessary,  approximate  subdivisions  may  be  made  of 
expenditures  involving  both.  The  cost  of  manufac- 
ture per  1000  cubic  feet  depends  largely  upon  the  total 
amount  of  gas  made,  decreasing  as  the  volume  of  pro- 
duction increases  and  increasing  as  the  quantity  made 
decreases,  and  a  slight  reduction  in  the  sales  will 
materially  increase  the  cost  of  manufacture  per  1000 
cubic  feet.  The  greater  the  sales  the  smaller  is  the 
cost  of  manufacture,  but  not  in  the  same  proportion 
for  the  total  cost  of  service,  when  we  include  the  dis- 
tribution to  customers'  meters,  and  it  is  therefore  of 
the  greatest  importance  in  discussing  the  rates  for 
which  gas  may  be  sold  to  clearly  distinguish  between 


24  Rates  for  Gas  Service 


the  cost  of  gas  in  the  holder  and  when  dehvered  to  the 
customers'  premises. 

In  general,  it  may  be  said  that  very  large  consum- 
ers involve  a  smaller  cost  per  1000  cubic  feet  than 
small  consumers.  The  question  naturally  arises, 
should  this  difference  in  the  cost  of  service  to  various 
classes  of  consumers  be  taken  into  consideration  in 
determining  the  proper  rates  for  service?  The  same 
rate  for  all  is  a  term  that  is  often  much  more  beauti- 
ful in  the  abstract  than  when  absolutely  applied. 
Sometimes  such  a  policy,  when  it  means  the  same  rate 
for  all  regardless  of  both  cost  and  the  effect  upon  the 
growth  of  the  business,  is  a  violation  of  sound  busi- 
ness principles  and  decidedly  against  public  policy. 
Often,  uniform  rates  for  a  very  large  territory  with 
the  same  class  of  customers  may  fulfill  all  require- 
ments, but  it  does  not  follow  that  the  best  interests 
of  all  concerned  are  conserved  where,  in  deciding  upon 
a  rate,  it  is  made  uniform  for  every  customer.  Very 
closely  related  to  the  fixed  and  variable  expenses  are 
capacity  and  outpii"  expenses,  ard  in  some  respects 
they  more  clearly  define  the  costs  involved  in  the 
two  classes  of  expenditures.  There  is  a  term  knovn 
as  "Consumer's  charge"  which  may  ordinarily  be  in- 
cluded as  a  part  of  the  fixed  costs  of  operation,  and 
such  expenses  are  directly  proportional  to  the  number 
of  consumers  taking  service. 

These  considerations  usually  lead  to  the  estab- 
lishment of  what  is  known  as  minimum  rates  or  a  min- 
imum bill,  which  should  be  high  enough  to  cover  the 
cost  to  the  company  of  the  consumer  independent  of 
the  quantity  of  gas  which  may  be  delivered  to  and 
used  by  him.  Many  times  the  actual  consumption 
of  gas  for  small  customers  is  not  a  great  factor  in 
the  cost  of  rendering  service  and  from  this  stand- 
point the  establishment  of  minimum  rates  would  seem 
to  be  sound  and  thoroughly  justifiable. 

While  no  rates  should  be  greater  than  the  value 
of  the  service  rendered,  it  is  not  necessarily  equitable 
to  charge  the  same  r?tes  to  all  regardless  of  the  actual 
cost,  and,  as  the  cost  of  manufacture  per  1000  cubic 
feet  depends  very  largely  upon  the  magnitude  of  the 


Rates  for  Gas  Service  25 

output,  such  a  policy  might  not  only  tend  to  dis- 
courage large  consumption  but  to  actually  increase 
the  cost  to  small  consumers.  It  may  even  happen  that 
large  quantities  of  gas  should  be  sold  at  even  less 
than  enough  to  yield  the  regular  rate  of  return  rather 
than  these  quantities  should  not  be  sold  at  all. 

This  phase  of  the  situation  is  often  entirely 
neglected,  not  only  by  gas  companies,  but  by  those 
responsible  for  the  adjustment  of  rates  on  an  equitable 
basis.  Failure  to  consider  such  opportunities  often 
results  in  losses  of  great  magnitude  and  thereby  re- 
sults in  increased  cost  to  all  consumers.  A  wise  and 
far-seeing  management  having  all  the  information 
available  can  usually  treat  such  matters  most  effect- 
ively by  taking  into  consideration  the  location  of  such 
large  customers  and  the  character  and  magnitude  of 
service  required. 

In  this  connection  it  is  of  interest  to  discuss 
the  advisability  of  charging  a  higher  rate  for  gas  when 
used  for  lighting  purposes  than  when  used  for  heat- 
ing and  cooking.  As  a  matter  of  fact  by  far  the  larg- 
est part  of  the  consumption  of  gas  is  for  purposes  other 
than  lighting,  and  this  probably  accounts  for  the  fact 
that  the  rates  for  the  two  classes  of  service  differ.  In 
addition  there  is  of  course  the  fact  that  the  use  of  gas 
for  lighting  concentrates  the  maximum  demand  some- 
what similar  to,  although  of  less  magnitude  than,  the 
use  of  electricity  for  lighting.  Gas  is  stored  in  the 
holder  with  little  additional  cost  as  compared  with  the 
storage  of  electricity,  so  that  the  peake  load  character 
of  the  demand  is  decidedly  of  smaller  consequence,  as 
regards  the  maximum  capacity  of  the  plant,  than  in 
the  generation  and  consumption  of  electrical  energy. 
Whether  use  for  lighting  or  fuel  on  the  customers' 
premises  the  gas  is  used  in  the  same  way  and  from 
the  same  service  pipes,  and  unless  there  is  a  very 
great  difference  in  the  magnitude  of  consumption  in 
the  two  cases  it  is  difficult  to  see  where  lies  the 
difference  in  the  cost  of  service  in  the  two  instances. 

Rate  of  Return  on  Investment. 
What  is  an  adequate  return  on  the  investment  for 
a    public    utility    corporation    is    a    question   that   has 


26  Rates  for  Gas  Service 

been  given  the  greatest  consideration,  nqt  only  by  the 
courts  of  the  country,  but  by  Federal,  State,  Municipal 
and  other  commissions.  In  the  U.  S.  Supreme  Court 
decision  in  the  Consolidated  Gas  Case  of  New  York, 
it  is  stated  that : 

"There  is  no  particular  rate  of  compensation  which  must  in 
all  cases  and  in  all  parts  of  the  country  be  regarded  as  suffi- 
cient for  capital  invested  in  business  enterprises.  Such  com- 
pensation must  depend  gioatly  upon  circumstances  and  locality; 
among  other  things  the  amount  of  risk  in  the  business  is  a 
most  important  factor  as  well  as  the  locality  where  the  business 
is  conducted  and  the  rate  expected,  and  usually  realized  there 
upon  investments  of  a  somewhat  similar  nature  with  regard 
to   the    risk   attending   them." 

In  considering  such  a  matter  it  is  evident  that 
under  present  industrial  conditions  the  best  interests 
of  societv  as  a  whole  are  subserved  when  the  share  of 
each  factor  of  production  is  high  enough  to  cause  a 
free  and  natural  distribution  of  capital  and  business 
ability  as  well  as  labor  into  all  utilities.  When  wages 
and  the  returns  on  investment  are  not  high  enough  to 
be  attractive  then  in  such  a  utility  there  must  be  a 
decline.  No  utility  will  be  furnished  unless  the  factors 
making  such  a  utility  attractive  are  present.  Wages 
must  be  high  enough  to  attract  competent  workmen, 
salaries  sufficient  to  engage  successful  superintendents 
and  managers,  interest  on  the  capital  legitimately  in- 
vested must  be  earned,  and,  in  general,  the  return  must 
be  high  enough  to  induce  investors  to  assume  all  risks 
and  responsibilities  that  are  involved  in  their  opera- 
tion. From  this  it  naturally  follows  that  the  rate  fixed 
for  service  rendered  by  public  utility  corporations 
must  in  the  long  run  be  high  enough  to  attract  all  of 
the  elements  necessary  for  the  production  of  that  serv- 
ice, taking  into  consideration  the  wages  to  be  paid,  the 
cost  of  superintendence  and  management,  the  interest 
on  the  investment  and  a  reward  for  the  risk  and  re- 
sponsibility entailed. 

Unfortunately,  however,  many  who  have  been  most 
active  in  the  development  of  public  utility  corporations 
in  recent  years  have  been  interested  therein  primarily 
from  the  speculative  standpoint  rather  than  as  legiti- 
mate investors.  Speculation  necessarily  involves  risk. 
An  investment  is  generally  considered  reasonably  safe. 
A  high  rate  of  return  rarely  compensates  when  there 
js  a  danger  of  losing  a  part  or  all  of  the  principal.   Cus- 


Rates  for  Gas  Service 


tomers  of  a  public  service  corporation  have  a  right 
to  demand  that  the  rates  they  pay  for  service  shall  be 
only  adequate  to  give  a  proper  return  upon  the  neces- 
sary investment  required,  and  not  so  high  as  to  make 
the  return,  upon  a  reasonably  safe  investment,  of  the 
magnitude  usually  demanded  in  a  pure  and  unadul- 
tered   speculative   venture. 

The  tendency  toward  legislation  afTecting  public 
utilities,  the  creation  of  wise  and  powerful  commis- 
sions and  the  enactment  of  numerous  laws  not  only 
regulating  but  actually  protecting  public  service  cor- 
porations constitute  a  definite  reduction  in  the  risks 
and  hazards  formerly  existing  in  many  instances. 

In  public  utilities  capital  cannot  be  turned  over 
as  frequently  as  in  commercial  enterprises,  due  to  (he 
relatively  large  proportion  of  the  fixed  investment. 
Legislative  regulation  of  public  utilities  through  com- 
missions may  in  some  respects  be  detrimental  to  finan- 
cial operators  who  endeavor  to  evade  their  obligations 
under  the  common  law  and  who  try  to  profit  by  the 
manipulation  of  capital  rather  than  through  legitimate, 
efifective  and  economical  operation  of  their  plants. 
Such  regulation,  however,  cannot  possibly  result  in 
permanent  injury  to  the  great  majority  of  investors 
and  to  the  utilities  themselves  if  honestly  applied  and 
administered  with  ordinary  care.  An  investment  along 
the  lines  of  and  in  the  spirit  of  such  laws  as  those 
which  have  been  upheld  by  the  courts  assures,  in  every 
case,  a  reasonable  return  on  a  fair  valuation  of  the 
plant. 

While  public  utilities  are  subject  to  many  condi- 
tions that  tend  to  increase  the  risks  under  which  their 
business  is  carried  on,  they  are  also  afiforded  a  great 
deal  of  protection  that  is  of  the  greatest  value  to  in- 
vestors. Many  are  natural  monopolies  engaged  in 
furnishing  service  that  has  practically  become  a  neces- 
sity and  for  which,  at  least  at  the  present  time,  there 
are  no  effective  substitutes.  An  investment  in  a  public 
utility  corporation  wisely  directed,  while  involving  a 
greater  risk  than  if  the  same  money  was  placed  in 
good  mortgages,  should  not  involve  hazards  equal  to 
investments  in  ordinary  competitive  enterprises. 


28  Rates  for  Gas  Service 

The  profits  of  a  business  consists  of  the  balance 
between  the  sum  of  expenses  and  the  total  income  of 
the  business.  It  is  the  difference  between  the  sum 
representing  the  operating  expenses,  which  includes 
rent,  salaries  and  wages,  fuel,  taxes,  interest,  depre- 
ciation, and  the  total  gross  revenue.  This  difference 
is  the  last  share  of  the  total  income  and  unlike  all  the 
other  shares  is  not  fixed.  It  simply  consists  of  what  is 
left  after  all  other  claims  have  been  completely  satified. 
Salaries,  wages,  rents  and  interest  are  usually  fixed 
at  a  certain  amount  per  annum  in  advance  and  are 
paid  out  of  the  gross  receipts.  The  amount  left  after 
these  shares  have  been  satisfied  belongs  to  the  owner 
and  represents  his  share  of  the  profits  of  the  busi- 
ness. Interest  and  profits,  notwithstanding  the  in- 
determinate quality  of  the  latter,  are  usually  measured 
upon  the  same  basis  and  are  included  in  what  is  gen- 
erally known  as  the  adequate  return  on  the  investment. 

The  difference  between  the  gross  revenue  and  the 
aggregate  of  the  legitimate  operating  expenses  for  a 
single  year  is  the  sum  usually  considered  as  the  net 
revenue  or  return  upon  the  investment.  As  the  gross 
revenue  and  the  operating  expenses  are  for  many 
reasons  subject  to  wide  variations,  it  is  manifestly 
unsafe  to  determine  rates  upon  a  single  year's  busi- 
ness. A  most  valuable  method  is  to  consider  the  gross 
and  net  return  per  dollar  invested  for  a  number  of 
years  of  operation.  By  doing  this  the  additional  in- 
vestment in  the  plant  from  year  to  year  as  well  as 
the  growth  of  the  business,  both  from  the  standpoint 
of  gross  revenue  and  operating  expenses,  is  obtained. 
In  fact,  many  important  conditions  affecting  the  com- 
pany are  brought  to  light  in  such  an  analysis. 

The  value  of  ascertaining  how  much  a  dollar 
earns,  both  gross  and  net,  is  due  to  the  important 
differences  between  public  service  corporation  and  or- 
dinary commercial  enterprises.  In  most  priva  :c  un- 
dertakings the  operating  expenses  can  usually  be 
greatly  reduced  or  even  practically  eliminated  if  for  any 
reason  the  gross  receipts  are  reduced  so  as  to  make 
the  business  unprofitable.  But  this  cannot  be  done 
-in  the  case  of  public  service  corporations,  who  must 


Rates  for  Gas  Service  29 

under  the  law  provide  service  to  all  within  the  terri- 
tory covered  by  the  distribution  system  provided  who 
request  it.  While  the  investment  in  the  private  enter- 
prise may  be  greatly  restricted  or  even  withdrawn, 
such  is  not  the  case  with  a  public  service  corporation. 
The  relatively  large  investment  in  plant,  equipment 
and  other  property  of  the  public  service  corporation 
means  that  the  interest  and  other  fixed  charges  go  on 
at  about  the  same  rate  whether  the  jdant  is  operated 
and  its  output  sold  or  not.  As  a  result,  the  public 
service  corporation  is  compelled  under  certain  ad- 
verse conditions  to  keep  its  plant  in  operation  even  if 
the  actual  operating  expenses  are  greater  than  the 
gross  receipts. 

A  complete  investigation  of  all  conditions  existing 
for  a  number  of  years  is  therefore  of  much  greater 
value  than  confining  the  data  upon  which  rates  are 
fixed  lo  a  single  year's  business.  The  public  service 
corporation  should  not  be  a  free  agent  to  do  abso- 
lutely as  it  pleases,  and  on  account  of  this  restriction 
certain  reasonable  protection  is  desirable  for  all  con- 
cerned. Free  and  Unrestricted  competition  between 
private  enterprises  may  be  of  the  greatest  benefit  to 
the  public.  Experience  shows,  however,  that  this  is 
not  the  case  with  public  service  corporations  where  the 
commodity  furnished  b}^  them  is  a  necessity  and  the 
character  of  the  business  such  as  to  be  a  natural  mo- 
nopoly. Competition  in  such  cases  inevitably  results 
in  a  bitter  struggle  for  supremacy  and  rates  so  low 
as  to  be  inadequate  to  maintain  the  proper  quality  of 
service  and  vield  a  return  sufficient  to  make  exten- 
sions  commensurate  with  the  growth  of  the  com- 
munity. Two  or  more  distinct  and  separate  corpora- 
tions providing  the  same  public  commodity  are  not 
likely  to  remain  separate  very  long.  Sooner  or  later  it 
will  be  self-evident  that  the  service  rendered  by  them 
independently  can  be  more  cheaply,  effectively  and 
in  a  better  manner  provided  by  a  single  operating 
system  under  one  management.  As  a  result  it  is  an 
invariable  rule  that  competition  which  is  often  thought 
to  be  preventive  of  excessive  rates  becomes  idtimately 
the  direct  cause  of  what  is  relatively  extortioi\ate  rates 

228254 


30  Rates  for  Gas  Service 


of  service,  when  compared  with  what  the  rates  should 
be  if  destructive  and  temporary  competition  is  pre- 
vented and  the  rates  equitably  fixed  under  proper  con- 
trol by  a  wise  commission. 

Again,  a  modification  of  rates  at  frequent  intervals 
is  undesirable,  as  it  renders  unstable  and  therefore  the 
more  hazardous  the  entire  business  of  rendering  serv- 
ice. Everything  of  every  character  tending  to  elimi- 
nate uncertainties  and  general  risks  on  the  one  hand, 
and  which  provides  protection  and  wise  regulation  on 
the  other,  definitely  increases  the  security  of  the  in- 
vestment, the  required  return  upon  which  is  thereby 
reduced,  the  general  stability  of  the  enterprise  is  ma- 
terially improved,  resulting  not  only  in  reduced  rates 
but  improved  quality  of  service. ' 

Conversely,  the  rate  of  return  on  the  investment 
and  consequently  the  rates  of  service  must  be  corres- 
pondingly high  as  long  as  unrestricted  competition 
threatens,  and  extraordinary  risks  involving  a  possible 
loss  of  a  large  fraction  of  the  investment  confronts, 
those  interested  in  the  progress  and  development  of 
public  service  corporations  in  general. 

In  the  end,  all  costs  of  every  character,  such  as 
litigation  and  other  expenses,  incident  to  the  estab- 
lishing of  rates,  whether  paid  out  of  public  funds  or  by 
the  public  service  corporations,  come  out  of  the  cus- 
tomers' pockets,  as  taxpayers  in  one  instance  and  as 
consumers  forced  to  pay  the  company  for  service  in 
the  other.  The  constant  danger  to  the  company  of 
having  its  investment  as  well  as  its  gross  revenue  seri- 
ously impaired  due  to  the  fixing  of  rates  upon  other 
than  a  sound  and  equitable  basis  involves  that  much 
extra  hazard  in  conducting  its  business,  necessarily 
requires  an  increased  return  upon  the  investment  on 
account  of  such  menace,  and  in  turn  will  ultimately 
result  in  rates  higher  than  they  should  be. 


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